Money and the Natural Rate of Unemployment

By Finn Ostrup | Go to book overview

8
The impact of inflation on bank
earnings

8.1 Introduction

The analysis is based on banks which operate under imperfect competition in the market for bank deposits. Due to imperfect competition, banks are able to derive above normal earnings. Real bank earnings have implications for the real economy in two areas: (i) as the bank earnings from deposits arise from imperfect competition, it constitutes a potential source of revenue for the government, and (ii) assuming asymmetric information between the suppliers of external finance to the bank, the level of real bank earnings affects the conditions under which banks can raise finance from non-deposit external sources and through this there is an impact on the real bank lending rate. We will argue that the level of real bank earnings is affected by inflation, constituting a channel through which money can influence the real economy. Due to the impact of inflation on real bank earnings, we will further argue that the banks' willingness to undertake lending is determined by fluctuations in the inflation rate which are effected by the monetary regime. An investigation of real bank earnings in Denmark shows real bank earnings to be influenced by inflation, a lower inflation causing a fall in real bank earnings.

Section 8.2 outlines the theoretical framework. Section 8.3 discusses the implications of real bank earnings for the real economy. Section 8.4 reports the findings from an investigation of real bank earnings in Denmark over the 1976–1996 period. Section 8.5 brings a summary and conclusion.


8.2 The theoretical framework

The household's demand for bank deposits

We consider a representative household which optimises utility over an infinite time horizon. Utility depends in each time period on

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